How to Determine How Large a Mortgage to Carry

Published on Dec 06, 2013 06:15 am

Few people have the money to pay cash for a home. Most home buyers finance the bulk of the cost with a mortgage. Multiple factors go into determining how large of a mortgage you can carry, including your income, your credit score, the cost of the home you want to borrow, the amount you have available for a down payment, your other debts and current mortgage rates.

Debt Ratios

Through decades of experience, the home-lending industry has devised two “debt ratios” for determining how large of a mortgage a typical borrower can handle without too much risk. Those ratios are 28 percent and 36 percent. As a general rule, your housing costs shouldn’t exceed 28 percent of your gross income, which is your income before any taxes and deductions.

Further, your combined debt payments — including mortgage, car loans, educational loans, and other debt obligations — shouldn’t exceed 36 percent of your income. If your anticipated debts are at or under these ratios, there’s a high likelihood that you will be able to meet your financial obligations and are more likely to approve your loan application.

It’s important to understand that lenders apply the 28 percent and 36 percent debt ratios only as a general guideline. Also recognize that just because you have the ability to borrow a certain amount of money doesn’t mean you should borrow that much. People can set themselves up for financial trouble when they make their home-buying decisions based on how much money they can borrow rather than how much house they actually need.

Costs Included

When lenders calculate how much of your gross income your housing costs will consume, they include four things in those costs: principal, interest, property taxes and homeowners’ insurance. That means, if you determine that you can afford a mortgage payment of $1,750 a month, as shown above, you need to include property taxes and home owners insurance in that amount.

Calculating Your Mortgage

Your monthly payment for principal and interest depends on three factors: the amount of money you’re borrowing, the length of the mortgage, and the interest rate on the loan. Easy-to-use mortgage calculators can help you run the numbers. Just enter the amount you intend to borrow, the number of months or years in the mortgage term (30- and 15-year mortgages are most common) and the interest rate, and the calculator computes your monthly payment for principal and interest. (Don’t forget to include property taxes and insurance when budgeting.)

About the Author
Cam Merritt has been a professional writer and editor since 1992, specializing in articles about personal finance and law. He has contributed to USA Todayand the Better Homes and Gardens family of magazines and websites. Merritt has a Bachelor of Arts in journalism from Drake University.

This article is provided for general guidance and information. It is not intended as, nor should it be construed to be, legal, financial or other professional advice. Please consult with your attorney or financial advisor to discuss any legal or financial issues involved with credit decisions.